The Statement of Cash Flows

Cash, liquidity,
and the cash flow cycle
The cash flow statement
preparing a cash flow statement
Its as easy as 1,2,3
Cash and Liquidity
Cash includes highly liquid marketable
securities.
These are items that can be converted to cash quickly
without loss of value. ( Treasury bills, notes, negotiable
CDs, and commercial paper.)
Liquidity refers to a firms ability to meet
financial obligations when due, and the
ability to fund investment opportunities.

A firms cash flow cycle significantly impacts its liquidity.


The Cash Flow Cycle
The movement of cash
through fixed assets and inventory,
into accounts receivable,
and finally back to cash.

Factors affecting the cash flow cycle
inventory turnover, collection period, payable period


THE CASH CONVERSION CYCLE




+ A/R Period
+ Inventory Period
- A/P Period
= Cash Conversion Period

The length of time between
when we pay cash for
inventory and collect cash
from our customers







A/R
Cash
Sale
Inventory
Labor
Assets, Taxes, Profits...
The Statement of Cash Flows
Focuses on the liquidity of a business, by
measuring cash inflows and outflows.
Shows where money comes from and where it goes
Three components of cash flow statement:
+/- Operating Cash Flows
+/- Investing Cash Flows
+/- Financing Cash Flows


The Cash
Flow Statement

- Operating Activities
- Investing Activities
- Financing Activities






Cash flow from operations:
Net Income $ 1,000
Depreciation 500
Decrease in Accounts Rec. 100
Increase in Inventory (1,200)
Increase in Accounts Payable 600
Decrease in Accruals (100)
Operating cash flow 900
Cash flow from investing activities:
Purchase Plan & Equipment (2,000)
Investing cash flow (2,000)
Cash flow from financing activities:
Increase in Long-term Debt 1,200
Sale of Common Stock 800
Dividends (500)
Financing cash flow 1,500
Change in cash 400
Beginning cash 1,000
Ending cash 1,400

Operating Activities
Inflows:
Sale of goods
Revenue from services
Interest income
Outflows:
Pay wages
Purchase inventory
Pay other expenses
Pay interest
Pay taxes



Investing Activities
Inflows:
Sale of fixed assets
Sale of investment
securities

Outflows:
Purchase of fixed
assets
Purchase of
investment securities






Financing Activities
Inflows:
New loans
Sale of stock
Outflows:
Repayment of loans
Repurchase of a firms own
securities (treasury stock)
Payment of dividends





Preparing a Cash Flow Statement
(Three easy steps!)
1. Calculate the change in all balance sheet
accounts.
2. Identify whether the changes result in increases
or decreases in cash flows.
3. Identify the source of the changes: operating,
investing, or financing activities.
Note: Some changes involve multiple activities.

Use the balance sheet to explain the
change in cash!
The balance sheet or accounting equation:
A = L + E
Since the accounting equation must remain
in balance:
A = L + E
The change in cash can be written as:
cash = L + E - (non-cash assets)

The change in cash:
The change in cash can be explained in
terms of all other balance sheet accounts:
cash = L + E - (non-cash assets)

CASH FLOW RULES


Asset Increase = Use
Asset Decrease = Source
Liability Increase = Source
Liability Decrease = Use



BUILDING THE STATEMENT OF CASH FLOWS
Belfry Company
Balance Sheet
For the Period Ended 12/31/00

ASSETS 12/31/99 12/31/00

Cash $1,000 $1,400
Accts. Receivable 3,000 2,900
Inventory 2,000 3,200
CURRENT
ASSETS $6,000 $7,500

Fixed Assets
Plant & Equip. $4,000 $6,000
Accum. Depr. (1,000) (1,500)
Net $3,000 $4,500

TOTAL ASSETS $9,000 $12,000
LIABILITIES 12/31/99 12/31/00

Accts. Payable $1,500 $2,100
Accruals 500 400
CURRENT LIABIL. $2,000 $2,500

Long-term debt $5,000 $6,200

Common Stock 500 1,300
Retained Earn 1,500 2,000
TOTAL EQUITY $2,000 $3,300

TOTAL LIABILITIES
AND EQUITY $9,000 $12,000

Slide 8 of 9
The change in Retained Earnings
Beginning RE $1,500
+ Net Income 1,000
- Dividends - 500
Ending RE $2,000
BUILDING THE STATEMENT OF CASH FLOWS
Belfry Company
Income Statement
For the Period Ended 12/31/00

Sales $10,000
COGS 6,000
Gross Margin $ 4,000

Expense $ 1,600
Depreciation 500
EBIT $ 1,900
Interest 400
EBT $ 1,500
Tax 500
Net Income $ 1,000

The Cash
Flow Statement

- Operating Activities
- Investing Activities
- Financing Activities






Cash flow from operations:
Net Income $ 1,000
Depreciation 500
Decrease in Accounts Rec. 100
Increase in Inventory (1,200)
Increase in Accounts Payable 600
Decrease in Accruals (100)
Operating cash flow 900
Cash flow from investing activities:
Purchase Plan & Equipment (2,000)
Investing cash flow (2,000)
Cash flow from financing activities:
Increase in Long-term Debt 1,200
Sale of Common Stock 800
Dividends (500)
Financing cash flow 1,500
Change in cash 400
Beginning cash 1,000
Ending cash 1,400

CASH COVERAGE
A variation on TIE to better get at cash flow












Slide 2 of 3
Cash coverage =
EBIT + depreciation
interest
Cash coverage =
$1,900 + $500
$400
= 6.0
FIXED CHARGE COVERAGE
A variation on TIE to include lease payments as fixed financial
charges equivalent to interest










Interpretation: Failure from excessive debt is due to the inability to pay
interest (fixed) charges which depend on the amount of
debt and the interest rate. Coverage ratios measure
financial charges relative to available income.

Slide 3 of 3
Fixed charge coverage =
EBIT + lease payments
interest + lease payments
Fixed charge coverage =
$1,900 + $700
$400 + $700
= 2.4